Investing in opportunity zones under the 2017 Tax Act
INSIGHT ARTICLE |
The Tax Cuts and Jobs Act (TCJA) has established opportunity zones providing generous tax benefits for investing. New section 1400Z allows any taxpayer to defer paying tax on the capital gain from the sale or exchange of any property held by the taxpayer to an unrelated person. Gains eligible for the tax benefit include:
- Long and short term capital gains
- Gains from a 1031 exchange
- Gains from sales of real estate properties but guidance is needed regarding the applicability of any recapture component
- Gains from sales of personal assets
- Gains from sales of stock
- Gains from sales of business assets
Those gains must be reinvested within 180 days in a qualified opportunity fund (QOF) to be eligible for the tax benefit. The QOF must, in turn, invest 90 percent of its assets in businesses located or property used in a low income and/or distressed community.
All states have submitted their first round of tracts for opportunity zone designation. Due to various natural disasters, some areas are considered distressed, which likely otherwise would not be. If applicable, the QOF must substantially improve the property within 30 months. In practical terms, that means the QOF must spend at least as much as they pay for the investment within 30 months of acquisition.
The QOF provisions give incentives to potential investors in a QOF by allowing for:
- Temporary deferral of capital gain recognition from the sold investment
- A possible step-up in the basis of their investment which will reduced the tax on their invested capital gain from the sale and
- Permanent exclusion of capital gain from the growth of the QOF investment if the holding period of the fund is at least ten years.
The basic concepts of the program are fairly simple and can be summarized as follows:
- TCJA encourages private capital to invest in underfunded communities domestically
- TCJA using the deferral of capital gains tax as an incentive
- A QOF is formed and self-certified. It can be organized as a corporation or a partnership. To self-certify, a taxpayer completes a form (yet to be released) and attaches the form to the taxpayer’s timely filed (including extensions) federal income tax return for that year.
- Before the end of the 180-day period beginning on the date of sale, an investor with a capital gain invests this gain into the QOF, elects to defer the gain, and takes stock or a partnership interest in return. By so doing, the investor gets an opportunity to defer tax on the capital gain.
- The QOF uses the investment to acquire and improve “qualified opportunity zone property.” This investment represents the QOF’s interest in the underlying business in the low-income/distressed community.
- The investor holds the interest for as long as he desires or for some period of time as may be stipulated in the investment agreement with the QOF.
- If the investor sells or exchanges his QOF interest before Dec. 31, 2026, they will recognize the deferred capital gain. If the holding period is at least five years, the investor gets a 10 percent basis increase that will offset some of the capital gain; there is a 15 percent basis increase if the holding period is at least seven years (ie, the capital gain liability will be reduced to 85 percent of the original level).
- The investor’s capital gain deferral period from the original sale ends on the earlier of the sale of the QOF or Dec. 31, 2026. The holding periods noted above are taken into account at that point.
- If the investor holds his interest in the QOF for at least ten years, the investor will qualify for a permanent exclusion of the post-acquisition gains generated from the investment in the QOF.
- In the case of an investment in a QOF where only a portion consists of gains to which this code section apply, such an investment will be treated as two separate investments. New money will not receive the tax benefit, only the rolled over capital gains will.
- The election to defer gain by investing in a QOF is available for 2017 transactions as long as the gain was invested within the 180-day period. A deferral election would need to be made on a 2017 amended return – for which precise instructions are forthcoming.
- A current list of approved opportunity zones can be found at the Department of Treasury's opporunity zones resources page.